Zeus Industries manufactures two types of electrical power units, custom and standard, which involve four factory overhead activities

Zeus Industries manufactures two types of electrical power units, custom and standard, which involve four factory overhead activities—production setup, procurement, quality control, and materials management. An activity analysis of the overhead revealed the following estimated activity costs and activity bases for these activities:

Activity Activity Cost Activity Base

Production setup $ 44,000 Number of setups

Procurement 13,500 Number of purchase orders (PO)

Quality control 97,500 Number of inspections

Materials management 84,000 Number of components

Total$239,000p

The activity-base usage quantities for each product are as follows:

 Setups

Purchase 

Orders Inspections Components Unit Volume

Custom 290 760 1,200 500 2,000

Standard 110 140   300 200 2,000

Total 400 900 1,500 700 4,000

a. Determine an activity rate for each activity.

b. Assign activity costs to each product, and determine the unit activity cost, using the activity rates from part (a).

c. Assume that each product required one direct labor hour per unit. Determine the per unit cost if factory overhead is allocated on the basis of direct labor hours.

d.  Explain why the answers in parts (b) and (c) are different.

Answer:

Production Quality 

Materials 

a. Setup Procurement Control 

Activity cost…… $44,000 $13,500 $97,500 

÷ Activity base…   400   900     1,500 

Activity rate…… $110/setup   $15/PO    $65/inspection 

Management 

$84,000 

  700 

 $120/component 

b. Custom Standard 

Number of setups…………………… 290 110 

× Rate per setup……………………… $110 $110 

Number of purchase orders……… 

760 

$  31,900  

140 

$12,100 

× Rate per purchase order………… $15  $15  

  11,400  2,100 

Number of inspections…………… 1,200  300  

× Rate per inspection…………………    $65  $65  

  78,000  19,500 

Number of components…………… 500  200  

× Rate per component……………… $120  $120  

      60,000    24,000 

Total product cost……………………  $181,300  $57,700 

÷ Unit volume…………………………    2,000      2,000 

Unit cost………………………………  $  90.65  $ 28.85 

c. The factory overhead allocated to each product on the basis of direct labor hours 

would be 50%, since each product has the same 2,000 direct labor hours. The 

factory overhead per direct labor hour for each product is computed as follows: 

$239,000 

4,000 per direct labor hour 

=  $59.75 per hour 

Since each product requires one direct labor hour, the factory overhead cost per 

unit is also $59.75 for each product. 

d. The factory overhead allocated to the custom power unit is much higher under the 

activity-based approach, compared to the direct labor method. The reason is that 

the setup, procurement, and quality control activities are not related to the number 

of direct labor hours but are instead related to the number of setups, purchase 

orders, and inspections. In addition, the custom product has a more complex design 

(more components) than does the standard product. As a result, the custom product 

will consume more materials management activities than will the standard product.